Cullen’s Tax Working Group: High on politics of envy, low on economic literacy

Gareth MorganTax and WelfareLeave a Comment

Tax Working Group head, Michael Cullen, asserts that the capital gains tax (CGT) is best described as a “tax on capital income”. Since when have capital gains been income? Show me any country’s national income accounts that include them in the measure of income.

 

There appears to be total confusion on Cullen’s part over what income actually is. And that is dangerous because such conflating of concepts threatens to compromise the whole basis of our income/expenditure-based taxation system. That regime’s integrity is dependent on revenue-raising taxes being neutral to economic decision-making. Labour’s desired for capital gains tax is anything but – it will discourage investment, and with the exemption for owner-occupied property, further direct the nation’s scarce investment resources into housing. This is the antithesis of desirable.

Firstly, understanding what income is, is critical to any literacy around the principles of income and expenditure taxation. As any standard economics and economic-statistics text will attest, income is payment (either in cash or kind) for production. Similarly, consumption, investment and saving denote how that income is deployed. The two sides add up. We have income tax that tax elements on one side, while GST taxes the consumption element of the other. Nowhere in this framework of income and spending accounting do capital gains appear as a source of national enrichment. So a tax on selective capital gains on realisation – especially one that does not provide tax deductions for capital losses – is nothing more than a selective transactions tax.

Why are capital gains not in the national income accounts? If I decide to pay you more for your house than you paid for it, nothing has been produced, earned or consumed in that transaction. You have simply swapped your house for cash, and me cash for the house. The price reflects the willing buyer, willing seller equivalence. We have swapped assets and agreed on a price to do that. It could just have easily been for a lesser price than you paid and it’s no different to what we do all the time when selling each other our secondhand goods. It’s not our business; we’re doing it because we no longer want use of that good. Which of us has achieved a windfall? Who knows, who cares?

And by the way there’s no GST and there’s no capital gains tax or tax deduction when selling other second hand goods for a gain or loss. Labour apparently thinks second hand houses should have a different rule. Its rationale? Because houses are “too dear”.

Let’s look at it another way. I decide to buy your company from you. How do I arrive at a value for what I think it’s worth? I look at the potential future tax-paid earnings, apply some allowance for risk and what I could otherwise earn on my money in the bank, and thus assign a discount rate for that future stream of earnings.

The result is a present value or cash price that I’m willing to pay now. If that price is above what you’ve spent building the business to, then that’s your good fortune, if it’s not, then you’ll accept it only if you’re happy to get the monkey off your back. Whatever – once again, a willing buyer, willing seller agreement is reached. Nothing is produced, earned or spent in this swap of factory for cash. We’ve both simply agreed to swap horses. No income is involved.

And it’s these transactions, wherein owners agree to swap assets, that Labour is deciding to tax. Irrespective of whether the gain in value over the holding period of one owner is a windfall, or is a reward for effort (improvements), or is because the vendor is ‘in the business of trading’ – under Labour’s capital gains tax it doesn’t matter; it deems any gain should be taxed.

Its proponents justify CGT as being an instrument to improve housing affordability – in other words, as a corrective tax rather than a revenue-raising one. Indeed in Labour’s case the rationale runs even deeper than that. As opposed to its indifference over how many cars, farms, businesses, or paintings I might own, the Left gets its knickers in a twist over how many houses one might have – even for own use. It has a deep-rooted preconception of what that number should be – one per household.

This is why Cullen deems that one house being exempt of his CGT, no more. Why such prejudice arises only Labour can answer; there is no economic rationale for it. Indeed, if houses were sufficiently cheap, I’m suggesting most people would have multiple homes. Labour has transmuted the blight of expensive housing into a declaration of how many homes it wants people to own. It’s a strain of socialism that should not fit easily with most New Zealander’s understanding of free choice and democratic capitalism.

Surely the government would be more productively engaged understanding and addressing why property is so dear, and addressing those causes, than issuing a decree on how many homes one should have, and bringing in a tax to enforce that.

A recent edition of London’s The Economist (November 22nd 2018) produces some arguments as to what is so nuts about capital gains taxes. Its list is partial in my opinion and omits the greatest fallacies upon which such tax is founded. Nevertheless let’s add The Economist’s arguments to those that underlie the rejection of such policies.

The magazine begins by stating that over recent years many rich world politicians have “woken up to the blight of expensive housing”. This of course applies to New Zealand and underlies Labour’s rationale for its tax review as well as for its self-defeating condition of excluding owner-occupied housing from that review.

Auckland has one of the highest level of house prices to income in the world (along with Paris, Amsterdam, Vienna, Oslo, and London). The others are all subject to a CGT so where is the rationale that it’s a lack of CGT on 30% of our housing that’s uniquely the cause of high house prices? This reality is why the Cullen TWG was never going to be credible and why the tax literate within it’s number objected to the CGT.

The Economist then goes on to blame “dysfunctional government polices” for the outbreak of house prices – especially how taxes on house transactions, like CGT on realisation, have fuelled the flames. The argument is that these slow transactions in the property market (because there’s a gap between what buyers pay and sellers receive – taxes), prevent people moving up and releasing housing stock for new entrants. The Economist advocates, as do I, that such transaction taxes be removed and instead annual levies be applied.

This inclusion of taxation upon all income to capital (not just homes but all non-financial capital) properly integrated into the current income tax regime is what underlies the proposal in our 2011 book The Big Kahuna, and after which  was established as the flagship policy of The Opportunities Party in the 2017 election. Getting rid of this loophole would do more than anything else to take away the tax-driven fuel for expensive houses. But it would achieve much, much more than just make houses less expensive. Crucially it would facilitate a 30% cut in income tax on other income forms (currently over-taxed) and it would improve the appeal of investment in productive businesses (as opposed to houses).

There really is no contest. Closing the tax loophole currently enjoyed by both owner-occupied housing and low return businesses and passing on the benefits of that to salary and wage earners and productive businesses, is day and night ahead of Labour’s capital gains tax proposals.

Cullen’s Tax Working Group: High on politics of envy, low on economic literacy was last modified: March 13th, 2019 by Gareth Morgan
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Gareth Morgan